Now that tax season is over, you might be expecting a refund.
When you get that tax refund, what will you do with it?
It’s important to carefully consider your options, and then make a choice that will benefit you in the long run.
This is especially true if you end up with a big tax refund.
What are Your Options with a Tax Refund?
It’s true that many people see a tax refund as a windfall (even though, for some, it’s just getting their own money back after lending to the government interest-free). Since it’s viewed as windfall money, many consumers decide to spend it. A tax refund can pay for a vacation, a new TV set, or any number of other things.
I’m actually using my very rare tax refund to…pay taxes. Last year, when my husband filled out his W-4 for an adjunct position at a local university, he forgot to claim exemptions. So he ended up having a rather large chunk of his paycheck withheld. He wouldn’t be bothered with changing it, so the state of affairs continued.
I, of course, make quarterly estimated tax payments because of my business. The result was that we ended up with a refund for the first time in years. The IRS lets you use your refund to automatically apply toward what you owe in the future, so we decided to put the refund toward our first quarter estimated tax payment. It works out because the amount of our refund almost exactly matches what we owe. It makes things convenient, and allows the money that I contribute to my “tax payment” fund in a high-yield account continue to grow (albeit slowly).
However, if I wasn’t in this position, I’d probably do something else with my tax refund.
Save, Invest, or Pay Down Debt
One of the more encouraging bits of data I read recently is that 64% of workers plan to save or invest their tax refunds. The Principal Financial Well-Being Index points out that a majority of recipients are planning to use their tax refunds in a savvy manner.
Saving or investing your tax refund can be a smart move. When you buy something, you simply consume. That money is gone, and all you have to show for it is a depreciating item. (Unless you go on vacation. There are advantages associated with certain experiences.)
When you save or invest, though, that money is working on your behalf. It earns interest, compounding so that you have more money in the long run. On top of that, the money you save or invest can help you in the future. It’s insurance against a rainy day. You don’t have to use debt to address a financial setback if you have money saved up. Saving or investing your money can be a smart way to use your tax refund.
Another option is to pay off your debt using your tax refund. If you have high-interest debt, this can essentially provide you with a great return on your money. Paying off a credit card balance with an interest rate of 18.99% will ultimately benefit you more in the long run than saving (APY of 1% if you’re lucky) or investing (annualized returns of 6% or 7% if you’re lucky).
If you have high-interest debt, consider using your tax refund to pay it down. You want to super-charge your debt pay off so that you aren’t using your resources to pay interest to someone else. The faster you get out of debt, the sooner you can start investing and saving so that you are earning interest and growing your own wealth.
What Will You Do with Your Tax Refund?
You can also consider adjusting your withholding if you have a big tax refund coming your way. That way, you can put your money to work for you all year, rather than losing time and compound interest to the fact that you are giving Uncle Sam an interest-free loan.
But, in the meantime, carefully think about what you want to do with your tax refund this year. You can accomplish a great deal toward your financial freedom with a smart move.
Are you getting a tax refund? What will you do with it?